Agustino Fontevecchia
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Bankia's former head, Rodrigo Rato, is being blamed for the collapse of the institution - Image credit: AFP/Getty Images via @daylife

The embattled Spanish government has begun the process of financial sector reform via the nationalization of BFA, which indirectly means the government has taken a 45% stake in a publicly traded company, Bankia. While Prime Minister Mariano Rajoy is set to announce further measures to strengthen the banking sector on Friday, with the BFA-Bankia takeover, the Spanish government is preparing to take control of the biggest chunk of toxic real estate assets in the troubled Iberian nation, taking the first major steps to try to fix its ailing financial sector.

This week, the government of Spain converted a €4.5 billion holding of preferential shares in BFA into equity, taking full control of the organization, thus taking a 45% stake in Bankia.

BFA was the result of a messy attempt at consolidation within the Spanish financial sector, fusing together 7 caixas or savings banks. Among them, Caja Madrid and Bancaja, giving the financial group one of the largest and most concentrated real estate exposures in Spain. BFA-Bankia’s construction and property-related credit portfolio reached €37 billion, according to The Telegraph’s Ambrose Evans-Pritchard.

Analysts at Barclays suggest that out of the bank’s €200 billion credit portfolio, 22% (or €44 billion) is tied in loans to constructors and developers (BFA-Bankia has a net provisioning ratio in the sector of about 43%).

Concentrating real estate assets in a country that suffered a massive housing bubble is by no means healthy for the banking sector, which has been under impressive amounts of stress. Both the IMF and the ECB have called for Spain to reform the sector, targeting a real valuing of banks’ assets (by marking them to market), and possibly instituting a “bad bank” to ring-fence those deemed toxic.

While PM Rajoy has publicly opposed the idea of a bad bank, Spanish daily El Pais suggests that BFA is indeed the country’s bad bank; it is also the country’s third largest holder of Spanish debt, with €29.1 billion. BFA had become the country's largest real estate company, displacing major names in the sector like Metrovacesa and Martinsa Fadesa, explained El Pais.

The decision to nationalize BFA, and thus 45% of Bankia, came after Deloitte, the bank’s auditor, refused to sign off on the bank’s books, noting €3.5 billion in inflated assets, explained Evans-Pritchard. As shares in Bankia tanked, the government took action, replacing former CEO Rodrigo Rato, with strong political ties to Rajoy’s own People’s Party (PP), with experienced banker Jose Ignacio Goirigolzarri, a former BBVA executive.

The news was well received by markets, with Spain’s Ibex-35 rallying 3.4% on Thursday after two consecutive days of losses. Bankia, which fell more than 22% in April, slid 1.2% while Banco Santander, Spain’s largest bank, gained 6%. In the U.S., major banks like JPMorgan, Bank of America, and Citi were all in positive territory.

Replacing Bankia’s management is the just the first step; Rajoy is expected to announce further measures to strengthen the financial sector in Friday. Analysts at Barclays suggest €7 to €10 billion in public funds could be injected into the sector. The replacement of management is important in that it shows that the government is willing to break with political ties to save its financial sector.

Spain remains the European enigma. With youth unemployment at about 50% and a deep economic crisis, some, like Nouriel Roubini, believe it will have to leave the Eurozone, possibly marking the end of the common currency. Others, like PM Rajoy, are confident the Iberian nation will be able to pull itself out of the ditch. Tomorrow’s announcements will be but the first step of a difficult journey for Rajoy and Spain.